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The Future of Central Banking: Inflation Targeting versus Financial Stability

The Challenge

The global financial crisis has led to a profound rethinking of the consensus on monetary policy. Before the crisis, most monetary economists agreed that "flexible inflation targeting"—in which central banks focus on maintaining price stability and stabilizing the output gap—was an appropriate and sufficient mandate for conducting monetary policy. Key assumptions underlying the consensus were that this mandate would automatically lead to financial stability and that the framework of monetary policy could deal with cross-border capital flows.

But the consensus is increasingly seen as inadequate. Monetary economists and central banks have broadened their perspective on financial stability, viewing it as a major concern for the conduct of monetary policy. For example, many central banks are now publishing financial stability reports and other indicators that reflect the state of the financial system.

How much of the precrisis consensus remains valid and how much rethinking of monetary principles is needed? Are central banks right to broaden their goals to include not only inflation targeting but also financial stability? And should they be given an explicit mandate for financial stability, such as targeting the growth of credit and asset prices?

After the crisis, which tools are most appropriate for the conduct of monetary policy and should the goals of inflation targeting and financial stability be pursued using the same tools? If the two goals come into conflict, how should central banks resolve the conflict? And to what extent should central banks be involved in financial regulation?

    Solutions

    Solution

    Central banks should adopt "default...

     
    Central banks should adopt "default countercyclical policy," using the "comply or explain" approach.

    Central banks should adopt "default countercyclical policy," using the "comply or explain" approach.

    Polity
    Solution

    Create a World Monetary Authority...

     
    Create a World Monetary Authority to promote a multilateral approach among central banks.

    Create a World Monetary Authority to promote a multilateral approach among central banks.

    Polity
    Solution

    Delivering price stability must remain...

     
    Delivering price stability must remain central banks’ primary goal.

    Delivering price stability must remain central banks’ primary goal.

    Polity

    Proposals

    Proposal

    The Future of Central Banking

     
    The future of Central Banking could be summarized as: i) Despite the current scenario which is impairing their credibility, the Central Banks will remain the most powerful and influential economic in ...

    The future of Central Banking could be summarized as: i) Despite the current scenario which is impairing their credibility, the Central Banks will remain the most powerful and influential economic institution; ii) Presently, there is a transition towards the multiple goal approach, which will include financial stability and, possibly, other objectives as well, such as growth and exchange controls. Hopefully, inflation should remain as the main objective; iii) An important trade-off: the multiple goal policy reduces the effectiveness of the Central Bank’s key role in managing expectations; iv) There will be an increasing need for additional monetary instruments over and above

    Polity
    Proposal

    The Future of Central Banking: Inflation Targeting versus Financial Stability

     
    The global financial crisis has made central banks in the advanced economies “rediscover” the importance of financial stability. In the emerging market economies, in contrast, central banks have a ...

    The global financial crisis has made central banks in the advanced economies “rediscover” the importance of financial stability. In the emerging market economies, in contrast, central banks have always regarded financial stability as one of their central responsibilities. In fact, a number of monetary policy instruments now called “heterodox” or “non conventional” in the context of the advanced economies, have been utilized for decades by central banks in emerging markets (e.g., liquidity or reserve requirements). The recurrent episodes of financial turbulence forced central banks in emerging markets to focus on financial stability, while in the advanced economies (under the influence

    Polity
    Proposal

    Presumptive Indicators should be used to drive Macro-Prudential Regulation

     
    Central banks are now being given the task of maintaining financial stability as well as hitting inflation targets.  With two objectives there needs to be, optimally, two instruments that can be used ...

    Central banks are now being given the task of maintaining financial stability as well as hitting inflation targets.  With two objectives there needs to be, optimally, two instruments that can be used separately for those purposes.  It remains essential for central banks to predicate interest rates primarily for the achievement of stable prices, i.e. hitting the inflation target.  The need is to find an additional set of instrument(s) that can allow them simultaneously to maintain financial stability.  Such instruments have been identified, and include such measures as state-varying capital and liquidity ratios, loan-to-value and loan-to-income ratios in the property market,

    Polity, Academia
    Proposal

    The Future of Central Banking: Inflation Targeting versus Financial Stability

     
    The Challenge Unconventional monetary central bank policies after the GFC (i.e., Fed’s QEs and ECB’s outright monetary transactions) have supported asset prices and restored some market confidence ...

    The Challenge Unconventional monetary central bank policies after the GFC (i.e., Fed’s QEs and ECB’s outright monetary transactions) have supported asset prices and restored some market confidence so far, but will they succeed in engineering more robust and sustainable economic growth, employment, and financial stability over the medium term? If yes, “inflation targeting” would surely loose its flavor, but if no, should central banks return to “inflation targeting” framework as a means to restore economic and financial fundamentals? Unconventional monetary policies are unlikely to succeed in restoring robust economic fundamentals and lasting financial stability over the long term. In the

    Polity
    Proposal

    The Future of Central Banking: Inflation Targeting versus Financial Stability

     
    Central Banks have to further develop a fully-flexed framework of macroprudential surveillance. This framework has to allow for a broad assessment for the build-up of financial imbalances even if infl ...

    Central Banks have to further develop a fully-flexed framework of macroprudential surveillance. This framework has to allow for a broad assessment for the build-up of financial imbalances even if inflation and inflation expectations remain subdued. This monetary policymaking strategy should also include a profound surveillance of money and credit developments and crosscheck the results against other analyses. This guarantees the symmetry of policy in expansions and contractions. ”Ultimately, this cross-check leads to a better assessment of the correctness of the policy stance. Early indications that a process of surging equity or house prices in the euro area might be interacting

    Polity

    Background Paper

    Background Paper

    Central banking post-crisis: What compass for unchartered waters?

     
    The global financial crisis has shaken the foundations of the deceptively comfortable pre-crisis central banking world. Central banks face a threefold challenge: economic, intellectual and instituti ...

    The global financial crisis has shaken the foundations of the deceptively comfortable pre-crisis central banking world. Central banks face a threefold challenge: economic, intellectual and institutional. This essay puts forward a compass to help central banks sail in the  largely uncharted waters ahead. The compass is based on tighter integration of the monetary and financial stability functions, keener awareness of the global dimensions of those tasks, and stronger safeguards for an increasingly vulnerable central bank operational  independence.

    Polity, Academia, Business, Civil Society

    Open Library

    Publication